Is Datadog Stock a Buy?

SaaS company Datadog (NASDAQ:DDOG) is a leader in cloud monitoring and has been on a growth tear since its 2019 IPO.

Over the last three months alone, DDOG shares have risen by more than 40% despite minimal earnings. Is Datadog a buy, or is the market pricing this exciting tech company too high?

What’s the Value in Datadog’s Technology?

One of the first questions to answer about Datadog is how much value its technology provides. The company provides a monitoring and analytics tool that gives users an integrated view of servers, cloud assets and other parts of their networks.

In addition to event monitoring, users can leverage Datadog for performance insights, data management and a host of other IT functions. The platform also allows users to create custom dashboards, making Datadog flexible and adaptable to the needs of various businesses.

Datadog can integrate with a variety of popular cloud computing platforms, such as Amazon Web Services (AWS) and Microsoft Azure and maintains strategic partnerships with both Amazon and Microsoft, making it a go-to provider for users of these two massive cloud computing service providers.

This combination of all-in-one convenience and integration with major cloud platforms makes it a valuable monitoring and observability tool but a drawback is its relatively minimal focus on small and medium-sized customers.

Datadog concentrates heavily on enterprise-scale customers, a fact which has helped the company build its line of annualized recurring revenue (ARR) but this strategy risks missing out on a more diversified and equally valuable base of smaller customers.

Stellar Growth vs High Valuation

Datadog’s most attractive feature by far is its growth rate. In Q3, revenues rose 25% year-over-year to $547.5 million, a record for the company.

Far from a one-off event, this level of revenue growth has been par for the course in recent years. To see how far the firm has come, look back no further than Q3 of 2020 when quarterly revenue amounted to just $155 million, less than a third of the present level. Management has also reported progressively higher revenues in every quarter since its IPO.

Q3 also saw the cloud provider turn a profit for the first time since Q1 of 2022. Earnings per diluted share totaled $0.06 on a GAAP basis.

While it’s not yet fully clear if Datadog will finally become reliably profitable, management projects non-GAAP net income of $1.52 to $1.54 per share for the full year of 2023.

Analysts foresee moderately positive earnings in 2024, with each quarter predicted to deliver $0.04-0.05 GAAP net income per share.

Another key growth metric for Datadog in Q3 was a 20% increase in the number of customers contributing $100,000 or more in ARR. This client base jumped from around 2,600 a year ago to 3,130 at the end of Q3.

Datadog’s growth is expected to continue unabated for quite some time. The  five year projection for compounded annual earnings growth is 31.8%.

Revenue growth over the coming year is forecast to be 35.9%. It’s worth noticing that this rate, if achieved, would be higher than the company’s revenue growth rate at any point since 2022.

With sustained profitability potentially on the horizon, plenty of room left for revenue growth and compelling technological advantages, Datadog has all the characteristics of an attractive growth stock.

Valuation remains a concern, though, with 20.1x sales, 72.0x forward earnings and over 1,245x cash flow. Those multiples place DDOG shares at a premium on all fronts.

Is the Market Pricing DDOG for a Best-case Scenario?

At its current multiples, Datadog must deliver the best-case growth to justify its pricing. One of the key risks to Datadog is that of competition in an increasingly saturated market.

With cloud SaaS emerging as a fast-growing business category, new startups are constantly cropping up, creating a market in which Datadog may struggle to stand out and repeat its historical rates of revenue growth.

There’s also the possibility that the free and easy cloud spending that has driven growth up to now won’t continue. Rising cloud costs are increasingly frustrating financial executives, potentially setting the stage for cutbacks. Will layoffs in the cloud sector carry over into SaaS products like Datadog’s platform and curb growth? It remains to be seen.

Finally, Datadog’s profitability isn’t certain in spite of the positive net income for brief periods in the past which were followed reports in the red. In order for DDOG to justify its valuation, the company will have to produce stable, predictable cash flows for its investors.

Is Now the Time to Buy Datadog?

Datadog’s revenue growth may be exceptional, but the stock seems too expensive at today’s multiples. This fact doesn’t reflect negatively on Datadog as a business, and it’s likely that the company itself will continue to grow well into the future. The price, however, is so high that it fails to account for challenges that could slow Datadog down.

Smart money also appears to be souring on Datadog. In Q3, institutional investors bought just $1 billion of DDOG shares while selling $3.65 billion. Though the disparity hasn’t been as pronounced, sellers have outpaced buyers by nearly $1 billion over the last year.

A final downside for investors is the fact that Datadog and other high-growth tech stocks may already be pushing the limits of their valuations.

The 12-month median target price for DDOG shares is $122.50, a 1.1% drop compared to the current pricing of $123.80. With investors increasingly looking unwilling to push growth stocks to higher multiples, those who buy DDOG at today’s prices could be in for a period of stagnant returns.

Datadog ultimately appears to be a hold at its current price. Investors who bought the stock at a lower cost basis already have strong double-digit returns and may benefit from the company’s ongoing growth. While there are no immediate threats to Datadog on the horizon, it seems like a classic case of a good business that’s too expensive to be appealing to investors.

With massive future growth rates firmly priced in, the company has little room for slower periods or unexpected downturns. Those interested in Datadog may want to watch for better buying opportunities, as future selloffs could make the stock attractive. For now, most investors will likely find more appealing risk-reward ratios elsewhere.

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